Chapter 9 Foreign Currency Transactions and an Introduction to Hedging

1. Chapter 9Foreign Currency Transactions and an Introduction to Hedging

2. Lecture Topics • Foreign currency translation • Translating transactions • Hedging foreign currency exposure • Disclosure requirements

3. Lecture References • Text - Chapter 10 • AASB - 1012

4. Key Concepts • Exchange rates • Foreign currency • Spot price • Hedge • Specific commitment

5. Foreign Currency Translation • Nature of translation • History of Australian foreign currency standards • Translation process and exchange rates • Understanding exchange rates • Direct and indirect quotations • Spot and future quotations • Buy and sell quotations

6. Translating Transactions • Simple foreign currency transactions Ozco • Spent $150 000 on behalf of Forco, a foreign entity related to Ozco • Ozco bills Forco for reimbursement and is to be expressed and paid in Forcos’s currency, FC50 000 • to: Spot rate FC1 = $3.0 FC50 000 = $150 000 • t1:Spot rate FC1 = $2.0 FC50 000 = $100 000

7. Ozco journal entries to record the transaction in Australian dollars • Prior to: Dr Reimbursable costs incurred 150 000 Cr Cash 150 000 payments for reimbursable costs incurred on behalf of Forco

8. Ozco • Immediate settlement Dr FC Cash 150 000 Cr Reimbursable costs incurred 150 000 foreign currency transaction on cash terms Dr Cash 150 000 Cr FC Cash 150 000 sale of foreign currency to dealer

9. Ozco • Settlement at t1 At to: Dr FC Account receivable 150 000 Cr Reimbursable costs incurred 150 000 foreign currency transaction on credit terms

10. Ozco • Settlement at t1 At t1: Dr Expense - FC exchange diff. 50 000 Cr FC Accounts receivable 50 000 revalues the receivable in foreign currency Dr Cash 100 000 Cr FC Accounts receivable 100 000 exchanges the receivable in FC for A$

11. Translating Transactions • Calculation of exchange differences in intervening reporting dates • Unrealised exchange differences at reporting date • Exchange difference at payment date • Translation of sale and purchase of goods and services • Qualifying assets

12. Translating Transactions • Treatment of foreign currency purchases and sales • Purchase of inventory and revaluation at reporting date 15 June Dr Inventory xx Cr FC Accounts payable xx 30 June Dr Accounts payable x Cr Revenue - FC exchange diff. x

13. Translating Transactions • Treatment of foreign currency purchases and sales • Payment 15 July Dr Expense - FC exchange diff. x Cr FC Accounts payable x Dr FC Accounts payable xx Cr Cash xx

14. Hedging Foreign Currency Exposure • Types of hedges • Hedges using foreign currency contracts • Other types of hedges • When do we have a hedge? • Important characteristics • Hedge transaction costs

15. Hedging Foreign Currency Exposure • Treatment of hedges of specific commitments • AASB 1012 • Hedge treated as part of underlying transaction • Specific commitment vs qualifying asset • Treatment of exchange differences

16. Hedging Foreign Currency Exposure • Treatment of other hedges • Hedging exposure of different types of underlying transactions • Hedging foreign currency denominated liability • Purchase transactions - inventory • Sale transactions • Hedging foreign currency borrowings • Hedging without the use of FC contracts

17. Hedging • Early termination of a hedge or derecognition of an ineffective hedge • Deferred gains and losses • Unresolved issues in hedge accounting • Recognition vs disclosure issues

18. Disclosure Requirements • AASB 8 • Net exchange difference and net gain or loss • Hedge transactions - AASB 1033 • Accounting policies and methods • Extent and nature of underlying financial instruments

19. Disclosure Requirements • Hedge transactions - AASB 1033 • Objective for holding or issuing derivative financial instruments • Interest rate risk details • Credit risk details • Net fair value of financial assets/liabilities • Details of hedges of anticipated transactions

20. Where to get more information • Other courses • List books, articles, electronic sources